How Is Money Created? Bank Loans, the Fed and the 0% Reserve Rule

Money in the US is created in two places: commercial banks create deposits when they lend or buy assets, and the Federal Reserve creates reserves and currency. Deposits are the money people use; reserves are the money banks use to pay each other. The Bank of England summed up the first part in one line: “the majority of money in the modern economy is created by commercial banks making loans” (Bank of England, 2014).

Scope. This guide explains the US system as of October 2026: bank deposits, Fed reserves, currency and what limits each. It does not cover crypto or stablecoins, other countries’ reserve rules or whether more money causes inflation in any given year. It is education, not investment advice. For how this fits the rest of the system, start with how the financial system works.

Data: Fed H.8 (deposits), H.4.1 (reserves, currency) and H.6 (broad money), via FRED. More on the measure itself in the broad money glossary entry.

When a bank makes a loan, it does not hand over someone else’s savings; it writes two new entries on its own balance sheet: the loan (an asset) and a deposit in the borrower’s account (a liability). That deposit is new money. The worked example below follows one illustrative loan through three steps.

The arithmetic: step 1 adds $100,000 of deposits, step 2 moves it (+$0), step 3 removes it (−$100,000), so the net effect over the life of the loan is $0. What remains is the interest the borrower paid. Step 2 shows why reserves still matter to each bank: payments between banks settle in reserves, so a bank whose deposits flow out must hold or borrow enough reserves to pay. Banks settle those payments over the Fed’s Fedwire system.

Not in the textbook sense. The old story says a bank must keep 10% of deposits as reserves, so $100 of reserves can support at most $1,000 of deposits (100 ÷ 0.10), a “money multiplier” of 10. In the US that ceiling no longer exists: the Fed cut reserve requirement ratios to zero percent effective March 26, 2020, which “eliminated reserve requirements for all depository institutions” (Federal Reserve). Before that, the top ratio was 10% and a lower tranche faced 3%.

Even before 2020, the multiplier described the order of events backwards. Banks lend first, if the loan is profitable and within their rules, and then make sure they have the reserves and funding to settle payments; the Bank of England’s article says banks do not “multiply up” central bank money. The US data show the same: in the year to mid-October 2026, deposits grew while reserves shrank.

The arithmetic: loans $14.21T − $13.17T = +$1.05T (+7.9%, unrounded $14,213.7B vs $13,168.5B); deposits $19.81T − $18.50T = +$1.31T (+7.1%); reserves $2.96T − $3.02T = −$0.06T (−1.9%). Loans and deposits are US commercial banks on October 15, 2025 and October 14, 2026 (Fed H.8, seasonally adjusted); reserves are October 15, 2025 and October 21, 2026 (Fed H.4.1), all via FRED. Deposits also change for reasons other than lending, such as banks buying securities, so the two lines do not match one-for-one.

A deposit is a bank’s promise to pay you; a reserve is the Fed’s promise to pay a bank. You can spend a deposit at a shop or send it to a friend. You cannot hold reserves at all: only banks and a few other institutions have accounts at the Fed, and they use reserves to settle payments with each other and to meet liquidity rules. The two are often confused because both are called “money” in headlines.

These are not parts of one total: reserves are not counted in broad money, and broad money overlaps with deposits. Compare them as sizes, not as a stack. Money market funds, $7.94 trillion in the week to October 21, 2026 (retail funds are part of broad money), are covered in where to park large cash.

The Fed creates reserves electronically, mainly by buying securities, and it issues paper currency only when banks order it for customers. When the Fed buys a Treasury from an investment fund in quantitative easing, two things rise at once: the bank serving the fund gets new reserves, and the fund gets a new deposit. That is how purchases can add to both kinds of money. Quantitative tightening, letting bonds mature without replacing them, works in reverse (QE and QT explained).

The pandemic is the clearest recent example. Fed assets went from $4.16 trillion on February 26, 2020 to $7.17 trillion on June 10, 2020, and broad money rose from $15.49 trillion in February 2020 to $21.79 trillion in March 2022, up 40.6% ($21,788.1B ÷ $15,492.8B = 1.406). Fed purchases, government transfers to households and new bank lending all fed into that rise; the data alone do not split it between them. On October 21, 2026 the Fed held $6.75 trillion of assets (H.4.1 via FRED).

Banks cannot create money without limit: each loan must be worth making and fit the bank’s rules. A zero reserve requirement removed one constraint, not all of them.

This is why the Fed influences money creation mainly through price. Raising the policy rate, as on September 16, 2026 (FOMC statement), makes loans dearer and so slows the creation of new deposits, with long and variable lags. How that decision is implemented is in how the Fed sets interest rates.

Money is destroyed whenever the process runs backwards: a borrower repays a loan, a bank sells a security to a non-bank investor, or the Fed shrinks its holdings. Each removes a deposit, a reserve, or both. Broad money fell from $21.79 trillion in March 2022 to $20.74 trillion in October 2023, a drop of about $1.05 trillion (4.8%), as rates rose and the Fed ran down its bond holdings; it was back at $23.34 trillion in August 2026, 5.7% above a year earlier (Fed H.6 via FRED).

“Banks create money from nothing” is true as accounting and misleading as economics. A single bank cannot lend freely: if its new deposits are spent at other banks, it must find reserves or funding to pay them, and if borrowers default the losses hit its capital. The 2023 bank runs showed that deposits created this way can leave in days. The counterexample to “the Fed controls the amount of money” is the same: the Fed sets the price of overnight money and the amount of reserves, but how many deposits banks create depends on borrowers and on banks’ own risk appetite.

Limits of this guide: figures are dated snapshots that are revised; broad money is published monthly with a lag; and other countries still apply reserve requirements. What money growth has meant for portfolios is covered in inflation and your portfolio.